Monday, April 28, 2008

Adjustable rate mortgages (ARM) have been long feared to be the crux of homeowners in the current housing market. Luckily this fears have not come to fruition yet, most likely because of aggressive actions the Federal Reserve has taken since last September. Lowering the target rate has also lowered the rates on several other indexes which are linked to ARMs.

The problem is huge, according to JP Morgan about $500 billion of adjustable-rate mortgage loans are due to reset this year and next.We have looked at ARMs at the beginning of April and noted the positive impact the reduction of the target rate had on ARM rates. The most common ARM type loans are 2-28 and 5-1 with initial rates fixed for 2 and 5 years respectively. The new interest rate is computed by adding a predetermined fixed margin to a selected index rate.

The rates on ARM indexes like LIBOR, CMT, or the Treasury Bill, to name some of the most common ones, have fallen significantly since the Federal Reserve's aggressive rate cuts. Mark Zandi of Economy.com wrote in late February, when the federal rate was at 3 percent:

"If the Federal Reserve had not eased rates, some $250 billion in subprime ARMs would reset higher this year, and nearly $100 billion of those mortgages would see rates jump up at least 2 percentage points. As it is, at the current 3 percent federal funds rate, some $190 billion will reset higher and only $60 billion will undergo more than a 2-percentage point increase."

"If the Federal Reserve quickly cuts the funds rate to 2 percent, as futures markets seem to expect, then $105 billion in mortgages will reset higher and almost no adjustable rates will increase more than 2 points."

But he is also cautious and thinks the problem is big enough to warrant a taxpayer funded bail-out:"To speed recovery, policymakers should establish a taxpayer-financed fund to buy mortgages and mortgage securities at auction."

As of March 18, payment shocks were only about 1%, S&P said, compared with 19% at the end of December, before the Fed started cutting rates. Since January rates have began to move higher again, but are still within a comfortable range compared to where they would be without central bank help. Here are the latest data on ARM rates:

click to enlarge

source: As ARMs reset, little of the expected chaos is coming to fruitionKathleen Pender, www.sfgate.comhttp://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/04/27/BU7P10BUDM.DTL&feed=rss.business